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The exchange of goods and services across country boundaries is referred to as the international trade. It results in world economy where the variables in the market are affected by worldwide events through their effect on supply, demand and prices. Consumers are able to access to more goods and services through international trade than they would do if they depended on domestic market. From the perspective of the companies, they are able to enjoy greater market for their products and hence increased revenues.
Adam Smith based on absolute advantage emphasized on international trade. Further contributions by David Ricardo based on comparative advantage, emphasized on international trade so that every country may be able to benefit from trade. The trade, however, needs to be regulated so that to benefit the participants. Since 1944, regulations are done by the Bretton Woods Institutions such as International Monetary Fund, World Bank and World Trade Organization. Based on the country’s participation on international trade, it may enjoy a favorable or unfavorable balance of payment. This makes international trade to draw a lot of attention from the policy makers to ensure the achievements of the internal micro and macro objectives while putting into consideration the international trade regulations and agreements.
In the year 2001, the International Accounting Standard Board (IASB) was formed to deliberate on the formation of Financial Reporting Standards (IFRS). According to IASPlus (2010), around 123 countries have been permitted to make use of IFRS in their laws. This represents a great increase in the use of IFRS compared to 19 countries that made use of it by 2003. By the use of IFRS, organizations are able to improve their daily operations1. To enjoy such benefits, however, they need to have the appropriate structure, processes, strategies, people, and data capabilities. These enablers help the organization to enjoy higher controls, efficiency and effectiveness in its operations.
Since its implementation, the IFRS have proved to be quite supplanting to the various Generally Accepted Accounting Principles (GAAP). Owing to this, all countries in Europe have adopted the new standards while many others in the world are in the process of embracing the standards in future. Given this nature of interest across the globe, it’s imperative to develop an understanding of the effect of making the accounting information well understood in the world and especially the effects on the international trade2. This paper seeks to create such understanding.
There is a general perspective on the fact that IFRS lead to an improved informational environment provided that the adoption of IFRS from GAAP reduces information asymmetry while improving the quality of financial reporting. This is because companies in different countries are more willing to participate in international trade if the cost of information is low and risks associated are low. According to a study by Rey and Portes (2005), there are different patterns of international assets and the information necessary to evaluate the assets may not be uniformly available to the market players in the international market. Apart from diversification in the international trade, availability of information about the events in international markets is even more important. Several international organizations such as World Trade Organization, United Nations, and the World Bank have been in the front line to help to harmonize accounting. Their participation to IASB arises from the need to facilitate the flow of investments across countries and hence strengthen the international financial structure.
IFRS have been credited for the ability to reduce the cost of information for the organizations operating in different countries3. Equally important has been the ability of IFRS to reduce the uncertainty among the investors. In effect, the international activities have increased among the countries that have managed to embrace the new standards especially the European countries.
IFRS and Information Asymmetry
Accounting provides means by which organizations communicate about their positions in terms of assets, liabilities, profitability and other financial parameters that may be beneficial to other market participants. This is relevant to all the information users across the globe to the extent that it guides decision-making and help in formation of sound judgments. Based on the users, accounting could be tax accounting which is necessary to the tax authority, managerial accounting relevant to the managers for decision making for internal challenges of the firm and lastly, financial accounting. Financial accounting provides relevant information to the stakeholders outside the organization. Financial information proves framework for the relationship between the firm and the outside world including relationship with customers, debtors and creditors. It’s also important in attracting capital towards organization.
IFRS provides guidelines on how events within the organization are disclosed to the outside users. This way, the events within the organizations are translated through the firm’s financial accounting. Apart from providing the financial position of the organization, financial accounting also provides information on how the organization has performed financially under the period covered4. This form of standardization has provided a uniform perception to the user all over the world. According to the research by Gehrig (1993), the difficulty experienced as people try to interpret financial statements compiled using different standards acts as hindrance to international trade.
A study conducted by Lew (2005) investigated various ways by which IFRS may promote international trade and policies through reduced cost of compliance. He states that the compliance costs will fall for the firms that are listed in the stock markets in different countries. This would result in a need to cross list on various stock exchanges. The harmonized accounting standards will also increase the confidence of the investors. In addition, IFRS increase the liquidity of the market and at the same time reduce the cost of capital.
IFRS have the effect of availing information to the users that enhances comparability and transparency among organization operating in different countries. Capital movement form a substantial component of the Balance of Payment Accounts as captured in the capital account. The existence of different accounting standards have been cited as a major cause of inefficiency that impedes movement of capital across countries while complicating international transactions.
According to Tsakumis (2007), various firms in different countries may adopt different disclosure decision as a result of different cultures in the globe. This necessitates investigation of the possible economic implication of the convergence of accounting standards.
IFRS and Economic Integration
There are different trade blocks that have been formed in the world to enhance international trade while gaining a competitive edge as a group rather than individual countries. Taking example of such unions as the East Africa Community and European Union, they are characterized with common market. These markets allow freedom of service movements and establishment among the member countries, free movement of goods and free movement of workers and persons. In addition, there is a free movement of capital goods through foreign direct investments among other forms5. According to Choi et al. (2001), to enable free movements of factors of production across the bounders and the free movement of goods, there is a need to harmonize the member countries market structures. Financial accounting is perceived as one of the main infrastructure that has to be out into consideration. As such, IFRS becomes a major strategy through which trade within the regional trade block can be enhanced.
Given the benefits arising from accounting harmonization within the economic unions, the process of accounting harmonization began in 2000 in Europe. European Union (EU) embarked on the process of adopting International Accounting Standards (IAS) which required that every listed EU company prepares its consolidated financial records as per the requirements in the IFRS starting from year 2005.
According to study by Francis et al., there has been a positive reaction by the investors as a result of the movements towards IFRS. This is because such harmonization is credited with better qualities of reports on the financial performance and position of organizations and minimizes asymmetry of information. Reduced asymmetry of information enhances contracting with external trade participants. IFRS have made the European capital market become more competitive. The market has increased in size due to improved liquidity of the market.
IFRS and Quantity of Trade
Argument by Bushman and Smith (2001) reveals three ways in which economic performance may be affected by information from financial accounting. These include the ability to distinguish between viable and better projects from the bad ones by the managers6. The second one is the ability to instill discipline among the mangers in expropriation and selection of projects. The third one, in which they give a lot of emphasis, is reduction of information asymmetry. Young and Guenter deliberate on the correlation that exists between the mobility of international capital and differences in financial reporting across countries. Is situation where the country’s financial reporting results into more clear information through greater disclosure, such countries are characterized with greater mobility in the international capital.
Ideally, majority of the investors are risk averse. In real trade set-up, majority of the component of trade cannot be hedged and, therefore, investors are at the mercy of nature based on how well their decision are made and how well they use the available information for speculation purposes. The quality of information acts has great contribution to the investors and may make them shun particular investments based on the risks associated. According to Guerin (2006), trade and foreign investments are largely influenced by information asymmetry, which also determines flow of equity. The performance of the firms is, therefore, tied to the available information. If there exists greater information asymmetry resulting from varying financial reporting, then the international trade component of foreign investments are low.
In most cases, firms intending to invest internationally, expand or to open subsidiaries in different countries may not raise enough funds internally to engage in such investments. Rather, they depend on the financing institutions for finances. If there exists information asymmetry that hinders availability and appropriate interpretation of the financial performance and position then, such funds may not be availed. Revenues received from exports are quite volatile and unpredictable according to Greenberg (2003). IFRS provide timely and relevant information, which makes it easier to get into contracts and enforce them more reliably. This is very important to the financial intermediaries, because, it enables the assessment of the potential risks and approximation of the possible returns. This increased financial comparability and increase transparency have the effect of increasing the size of the firms and hence the country’s economic growth. Economic growth leads to further increase in international trade and, therefore, IFRS can be said to be potentially capable of increasing the size of international trade.
Convergence between Developing Countries and Developed Ones
International trade involves either bilateral or multilateral relationship between or among countries respectively. Such relationships are relevant for the countries to be able to take advantage of their respective comparative advantages. As measured by book value response coefficient, IFRS provide value relevant information. In essence, the demand for international standards in accounts preparation and presentations has resulted from the high cost and difficulties in comparing firms listed in the stock markets7. The other additional costs result from the requirement to make the financial statements, as done in the host counties, hence duplications of work. This, coupled with exchanges pressure, has led to difficulties in international trade especially among the developing countries.
As mention earlier, convergence of accounting standards have the effect of increasing the mobility of capital. However, the standards established for the sake of the developed countries may be of less use to the emerging markets. For example, the US IFRS and GAAP are aimed at providing information mainly to the stock market participants. This is contrary to the emerging markets such as Africa, China and Latin America where much of information provided in the reports are aimed at providing information mainly to the owners, creditors and the tax authority. Information is perceived to be relevant if it enables the users to evaluate the present, past and make future expectations for the firm. For this reason, IFRS that are prepared mainly for the stock market participants may not be that useful for the tax authority and creditors as is for the case in the developing countries.
According to Saudagaran and Diga (1997), the underlying infrastructures available in the developing markets are significantly different from those in the developed countries. In addition, the reliability and relevance of the financial statements in the developing countries’ capital markets are dependent on market integrity factors8. These include the extent of owner’s rights and the availability of insider-information trading. A research by Jenice (2006) found out that there was a significant change in returns when earnings were announced in Johannesburg Stock Exchange (JCE) than they did in Bolsa Mexican de Valores (BMV). This means that timeliness and relevance of the financial statements should be emphasized in IFRS for the investors in the developing countries.
IFRS and Challenges in Trade Function and Customs
From a positive perspective, IFRS are viewed as a way of increasing international trade and investments as a result of increased transparency and low cost of obtaining information across the borders. However, from a complex perspective, the scale of the required adjustments and their scope make IFRS beyond the matter of accountants alone. In fact, majority of the IT, tax and supply chain professionals who have international experience believe that IFRS will bring substantial changes in their companies. These changes may extend to the way they are compensated and measured as well as how they conduct their job.
In case of US, the GAAP for the valuation of the inventory make use of historical costs. These costs assume that no change has taken place since the acquisition of particular stocks. In addition, GAAP in US does not allow any revaluation of stock. However, with the introduction of IFRS, the values of the inventories should always reflect the prevailing prices in the market and hence need for revaluation. This may pose a challenge in claiming back to the companies experiencing slow inventory turns. The challenge will be even more intense as a result of the allowances for in drawback programs while importing, filing claims or exporting.
Majority of companies, even in US make use of Last-In, First-Out (LIFO) method of inventory accounting. The use of this method is extensive due to such advantages as income tax offers that it gives to the companies. In U.S., this method is allowed by the GAAP and it is normally used in accounting for qualification in trade agreement8. However, this method is no provided for in the IFRS. This means that organizations have to change such accounting methods to the others allowed in the IFRS. There is possibility that, as a result of this, companies may lose access to preferential market that’s normally provided by the trade agreements.
In the IFRS, there is the requirement that the party with the responsibility, beneficial item use and risk should be separated from the party that owns the item. This means that some agreement that was negotiated before is not recognized. This means that some contracts are made with the customers and the suppliers before the adoption of IFRS may have to be reworked, reviewed and renegotiated9. This may have a lot impact on the prevailing value chain that characterizes the international market. This may include such consignments as long-term supply contracts and leases. Changes that may be required in the process of adopting the IFRS may bring changes to the contractual obligations for the entities and individuals involved in the current operations. This may as well include costs, transfers and prices for the services or goods in question. Based on the configuration of some agreements and contracts, international trade functions and customs should help in ensuring that companies declare to custom authority accordingly as required in the IFRS.
IFRS bring about different methods of computing costs and profits for the companies. For this reason, the income tax that is associated with the intercompany transaction may alter contracts that relate to intellectual property rights. Most of the agreements on license fees, royalty rates and cost sharing agreements between companies are normally based on the required inter-company returns. In most cases, to defend and determine the profits and costs of these kinds of inter-company arrangements, analysis for transfer pricing are prepared. Payments in relation to such arrangements may be considered additional expenses to the companies’ payables depending on the inter-company structure10. The challenge that IFRS may pose is the additional work to through changes that are made to the licenses, royalty and agreements on cost sharing so as to ensure that the imported merchandise are properly appraised as per the customs.
The value chains in the global market are highly intertwined among those of the corporations, customers, suppliers and third parties. Implementation of the IFRS may face the challenge of interfering with the existing systems and, therefore, if implemented it may result, at the beginning, to changes in the smooth flow of trade.
IFRS and the Developing Countries
The argument that adoption of IFRS will be useful to the developing country is plausible. There are, however, some pressures to countries that do not have companies listed in the stock market or companies without stock market to embrace IFRS11. Such requirements may not be bad but are mainly structured to fit the requirements of the users in the developed countries. In the developing countries, the accounting systems are traditionally guided by the country’s cultural, socio-economic and political circumstances. For this reason, harmonizing the accounting standards by endorsing policy that do not fit the developing countries will reduce their participation in the international trade.
Developing countries are also characterized by unfavorable balance of payments. In most cases, these countries lack in capital and mineral endowments and, therefore, imports more than they exports. The Bretton Wood Institutions such as the IMF have constantly been in the attempts to rescue such economy and ensure favorable participation in the international trade of these developing countries12. One major approach that has been used by these institutions is to encourage Foreign Direct Investments (FDI). This is because, such investments help to increase outputs for the country and also avail the necessary capital goods and human capital compliments necessary to ensure the country’s growth.
Participants of the foreign investors in the developing countries help to increase the exports for the country and hence correct deficiency in the balance of payment. This effort cannot work in situation where standardized information with regard to the financial status and performance cannot be accessed. In return, foreign investors may not be attracted to such country due to the lack of clarity on the possible risks so as to determine the expected rate of return13. However, the adoption of IFRS is capable of removing the differences in information expectation between the developed and the developing countries. In this case, investors become indifferent as far as informational asymmetry is concerned across the globe and, therefore, available investment opportunities in the developing countries may be seized timely and confidently. This increases the volume of trade for the developing countries with time.
From a different perspective, several accounting scholars argue that decision by investors to invest in certain developing country is not dependent on the system of financial accounting in that country. Ole and Perara are of the idea that its failure to implement IFRS that promote international investments. They argue that given that the developed country’s participation in the international trade owes to their development that happened without IFRS, then the developed country can also develop and increase they international trade participation without IFRS.
In conclusion, IFRS as noted have been adopted by many countries in the world especially the developed ones such as all countries of Europe. There is a great potential of IFRS to increase the internal trade as a result of the information asymmetry reduction and information cost reduction. However, it is possible that implementation of the IFRS will reduce the volume of trade and participants. This is especially when the IFRS are imposed in developing countries where they don’t fit or where IFRS provoke changes that lead to interruptions of trade.